AP Econonomics_Unit_One_Introduction.ppt

“If ignorance paid dividends, most
Americans could make a fortune out of
what they don’t know about economics.”
--Luther H. Hodges
U.S. Secretary of Commerce (1961-65)

Conan’s biggest regret at Harvard?
Skipping economics
BOSTON (AP) – Conan O’Brien was a prankster during his
Harvard years, but he also credits his success to hard work in
the classroom. The late-night TV host spoke to an audience
of Harvard University students on Friday about the value of a
liberal-arts education and about his time at the Ivy League
school…
Asked about his biggest regrets, O’Brien said he still kicks
himself for shying away from an economics class because it
intimidated him. “That was knowledge that I don’t have, and
I’ve always regretted it, “ he said. “I wish I had taken that
course.”
--Associated Press, 2/13/2016

Welcome to The Economic
Way of Thinking
 People choose for good reasons.
 Everything has a cost. (Nothing is free!)
 Incentives matter.
 People create economic systems to influence
choices and incentives.
 People gain from voluntary trade.
 Economic thinking is marginal thinking.
 The value of a good or service is affected by
people’s choices.
 Economic actions create secondary effects.
 The test of a theory is its ability to predict correctly.

Unit 1—Basic Economic
Concepts
Aligned with Mc-B: Ch. 1, 2, 6, & 37
AP Classroom Personal Progress
Check 1
AP Classroom Website

Microeconomics vs.
Macroeconomics
 Micro – part of economics concerned
with individual units such as firms
and consumers. (The view from Main Street)
 Macro – part of economics
concerned with the economy as a
whole. (The view from the international space
station)
Ch. 1 Limits, Alternatives, and Choices

Economics is…
 The study of how people satisfy their
needs and wants by making choices
under conditions of scarcity.

Scarcity and Choice
 Resources are limited – as a society
and as individuals we must make
choices

Opportunity Costs & Trade-
offs
 The value of other products/services
forgone or sacrificed to obtain a unit
of product/service when making a
choice
 “There is no such thing as a free lunch”
 NFL or TANSTAAFL
 Cost = “give-up”

Can you apply the concepts of opportunity cost and
trade-off to this cartoonist’s point of view?

What’s going on at this cross-country meet?? What
choices are being made? Trade-offs? Opportunity
costs?

Other Things Equal
Assumption
 “ceteris paribus”
 Economic models examine two
variables. Everything else is constant
 Dependent and Independent variables

Think cause & effect!
 Price & Quantity or Income &
Consumption

Which is the dependent variable?

Correlation
 Dependable association between two
variables
 Correlation does not always indicate
causation!!
 X increases, Y increases, X may not
cause Y although there may be a
correlation
 X = educational level, Y = income, X
may not cause Y

“The Economizing
Problem”
1) Resources are limited (scarce)
2) Wants are unlimited (insatiable)
The study of economics will begin to
explain how this problem is resolved
or minimized…

Resource Categories
(Resources are also called “factors of
production” or “factors”—these terms are
synonyms)
1. Land – all natural resources “gifts of nature”
arable land, forests, oil, etc.
2. Labor— “human capital”, “know-how”, effort
3. Capital – manufactured aids to production i.e.
tools, machinery, factories, trucks, technology
(Money is not considered a capital resource!)

Resource Categories (cont.)
 Consumer goods vs. Capital goods
 Consumer goods satisfy human wants directly while
capital goods aid in the production of consumer
goods and other capital goods
 4. Entrepreneurial Ability –four factors
separate the entrepreneur from traditional
labor:
 taking initiative

making policy decisions
 providing source of innovation
 bearing the risk of loss/failure

AP Econonomics_Unit_One_Introduction.ppt

In economics, Investment refers to the
purchase of capital goods. i.e.
“Investment in plant and equipment”
1) Property Resources: land and capital
2) Human Resources: labor and
entrepreneurial ability

Production Possibilities
Curve (Key Graph p. 12)
 There are four assumptions in this
model
 1. Full Employment
 2. Fixed Resources
 3. Fixed Technology
 4. Two Goods

Table
 “Islandland”: Possible combinations of
coconuts and fish utilizing all available, known
resources
A B C D E
Coconuts (x) 0 20 25 28 30
Fish (y) 40 30 20 10 0
 At any point in time, a full employment/full
production economy must sacrifice some of
product Y to get more of product X (& vice versa)

Curve
 Graph—(you do it, copy mine on board, get used to drawing lots of graphs!)
 Producing outside the curve is infeasible.
 Producing inside the curve is feasible but
not optimal.
 Producing ON the curve is productively
efficient (max use of resources,) not
necessarily allocatively efficient (the quantity
society desires of each) [lots more on this in micro!]

Law of Increasing
Opportunity Costs
 As production of a particular good
increases, the opportunity cost of
producing an additional unit also
increases, (give up more of Y to get one more X.)
 Rationale: Resources are not completely
adaptable to alternative uses!
 This explains why the curve is concave
to the origin (bows out from the origin)

Optimal Allocation: MB=MC
 What combination of coconuts and fish
should be produced?...it depends on
society’s desires and values.
 Optimal output occurs where marginal
cost = marginal benefit.
 General rule: as output increases, MB
declines while MC increases…
 Graph

Economic Growth and PPC
 The growth of economic production can
be depicted as an outward shift in PPC.
 Increases in resources and
improvements in technology are two
major factors that enable a PPC to shift
outward.
 PPC may also contract and shift inward
(war, natural disaster, pandemic)

Present Choices Impact the
Future
 A production alternative favoring
capital goods will enable the economy
to grow more in the future as
compared to an alternative favoring
consumer goods. (think of China vs. Las
Vegas:)

Ch. 2 Economic Systems & Resource Allocation

An Economic System responds to
the economizing problem by …
 Answering 3 Fundamental Economic
Questions:

(1) What goods and services will be produced?

(2) How will the g/s be produced?

(3) For whom? Who will get to consume the
g/s?

What goods/services should be
produced?
 Those that satisfy needs and wants to
consumers and provide economic profit to
producers
Our market system does this--think about
what is produced for our consumption today
compared to the recent past and how it
adapts: smart phones and TVs, video games,
vehicles, medicines, etc.

How should goods and services be
produced?
 How to fuel cars?:
 Gas, Electric, Hybrid, Ethanol
 How to teach?:
 Large lecture with 100 students per class (less
labor)
 Smaller discussions with 15 students per class
(more labor)
 In other words, how should resources (land, labor,
and capital) be combined to achieve maximum
profits/efficiency in producing g/s?

For Whom?
Who gets the goods? Who is the “market?”
…those with the willingness and ability to
pay who desire to satisfy a need or want.
 Q: How do we distribute income?
 A: Through Factor Payments:
The income received for supplying factors
of production (land, labor, capital,
entrepreneurial ability)
This represents a cost to producers for
factors of production

How are the 3 questions
answered? It depends on the
economic system…
 Command System
 a.k.a. socialism or
communism

Controlled by strong,
centralized
government, which
owns most resources
 Usually focuses on
planning

Problems: incentives
and coordination

Economic Systems
 Market System

Capitalism, based upon
Supply and Demand
by individuals, who
own most resources

Private property rights

Choice, competition,
profit/loss

Is this Chaos? Why does it all
work?
 Self interest
 "It is not from the benevolence of the butcher, the
brewer, or the baker, that we can expect our dinner,
but from their regard to their own interest.“
– Adam Smith, The Wealth of Nations (1776)
 Acting in our own self interest to satisfy needs and
wants (Not the same as selfish!)
 Laissez Faire: literal translation is “let them
do”…minimal Govt intervention. G exists only to
protect private property rights and promote
competition.

Invisible Hand
 “Invisible hand” is how the
market regulates itself
 “he intends only his own gain,
and he is in this, as in many
other cases, led by an invisible
hand to promote an end
which was no part of his
intention. Nor is it always the
worse for the society that it
was not part of it. By pursuing
his own interest he frequently
promotes that of the society
more effectually than when he
really intends to promote it.” –
Adam Smith, Wealth of
Nations

Competition
 – the struggle among producers for the
dollars of consumers, driving force for
innovation

Pros and Cons of a Market System
 Advantages
 Economic Efficiency

Responsive to change
(coordination, adapting)
 Economic Freedom

People can buy/sell
what they want (mostly)
 Economic Growth

Innovation/Progress
 Disadvantages
 Equity?

Not to achieveequality,
but is it “fair?”
 Security?

For income, necessary
g/s, housing,
healthcare?
 Market failure?

Can result in too much
of a “bad” or too little of
a “good” produced?

“Our” System (and most of the
world’s): Mixed Economic System
 Markets with active,
but limited
government

Combination of Market
and Command
economic systems

Protect private
property rights!

Regulations to solve
market failures,
promote competition,
provide equity,
security, other goals?

Circular Flow Model
Definitions
 Household
 Person or group living in the same
residence; consumers of products
 May own resources (land, labor, capital)
 Firm
 Organization that uses resources (factors
or production) to produce a product
 Firms transform “inputs” into “outputs”

Definitions
 Resource (Factor) market
 where firms purchase the factors of
production from households

Most notably, labor

Also borrow money to obtain resources
 Product market
 Households purchase goods and
services produced by firms

Oh no, circular flow! (key graph p.
40)

Absolute Advantage
 A person (or nation) has an absolute
advantage relative to another person
(or nation) if they can produce more of
a good or service with the same
amount of resources.
 Example: The US can produce more steel
and more semiconductors than China,
therefore US has an absolute advantage in
both. So why should it trade with China?
Ch. 37 Comparative Advantage & Trade (pp. 756-
763)

Comparative Advantage
 A person (or nation) has a comparative
advantage when they produce the
good or service with a lower
opportunity cost (even if it does not
have an absolute advantage.) This
leads to specialization in production
 With specialization, total output will
be greater and production will be
more efficient.

Graphical Analysis Example
 Using production possibilities curves
of two nations with the following
assumptions for simplicity:
 Constant costs (straight line trade-off)
 Different costs (opportunity costs!)
 Example with Graph: USA and Brazil
 Easy question: which country has the
absolute advantage?

Tougher question: which country has the
comparative advantage?
 The principle of comparative
advantage says that total output will
be greatest when each good is
produced by that nation which has
the lowest domestic opportunity cost
for that good. Key principles:
 Be the lower-cost producer.
 Give up less than your trading partner
does to produce the good.

Terms of Trade
 Set up the cost ratios to determine
the possible terms of trade. To
engage in trade, a nation must be
able to pay a lower cost for that good
in the world market than it would pay
domestically.
 What are the terms of trade for the U.S.
and Brazil in our example?

Gains from trade
 Trading possibilities line—PPC revisited
 With trade, the exchange ratio for both
trading partners improves (they both give
up less!)
 Specialization based on comparative
advantage results in a more efficient
allocation of resources and larger outputs
of both products will be available to both
trading partners.

 With increasing costs (concave PPF),
specialization is not absolute. The
more a person or nation specializes,
the more it gives up. This is why we
see people complete their own taxes
or multiple nations produce autos.
The US even produces coffee! (in
Hawaii)

Marginal Analysis and
Consumer Choice
Total Utility
Marginal Utility & Diminishing Marginal
Utility
Utility Maximization Rule
Ch. 6 Consumer Behavior (pp. 116-
125)

Rational Behavior
 In economics we make the
assumption that people act out of self
interest
 Consumers want to maximize utility.
Utility is a measure of the satisfaction or
pleasure obtained from the consumption
of a good or service
 Firms want to maximize profits.

Marginal Analysis
Economists measure the effects of
incremental unit changes, asking
“what’s one unit more?”
 Marginal Cost—the cost of producing
one additional unit of a product
 Marginal Benefit—the benefit of
consuming one additional unit of a
product
 Hint: marginal = additional

Utility Defined (Key Graph p. 118)
 “utility” is want-satisfying power. The utility of a
g/s is the satisfaction or pleasure it provides to
a consumer.

Not a synonym for “usefulness” (as in utility
knife)

utility is subjective and difficult to quantify (so
we’ll call the measurement of utility “utils”)
 Marginal Utility—extra, additional,
incremental “utils”
 Total Utility—sum of all marginal utilities

Law of Diminishing Marginal Utility
 At some point of consumption, marginal utility will
begin to decline (at unit 2 in the example in the
Key Graph p.118.)
 Sometimes, consumption has increasing marginal
utility initially, then a point is reached where the
law of diminishing marginal utility kicks in. Think
about eating M&Ms or potato chips one at a time.
 Analyze the concepts of marginal thinking in the
following photo…

OR
OR OR
How is marginal utility applied in
these examples?

Theory of Consumer
Behavior
 Assume the following for simplicity:
 Rational Behavior—consumers attempt to maximize
their total utility.
 Preferences—each consumer has clear-cut preferences
 Budget Restraint—at any given time, a consumer has a
fixed money income.
 Prices—individual consumers do not influence product
price.
 Consumers can’t have it all (scarcity) and must make
choices and compromises about the mix of goods and
services—how do consumers optimize their choices?

Utility Maximizing Rule
 In order to reach equilibrium and maximize satisfaction
(total utility), a consumer should allocate his or her
money income (fixed budget) so that the last dollar
spent on each product yields the same marginal utility.
 In order to compare utility derived from differently
priced products, marginal utility must be stated on a
per dollar basis:

MU of A = MU of B ex: 8 > 2_ what to
do? P of A P of B $2 $1 (buy
more A
and less B)

Practice Question
 A consumer is spending all of her income and
receiving 100 utils from the last unit of good A and
80 utils from the last unit of good B. If the price of
good A is $2 and the price of good B is $1, to
maximize total utility the consumer should buy

A. more of good A.
 B. more of good B.

C. less of good B.
 D. more of both goods.
 E. less of both goods.
Answer: B

AP Econonomics_Unit_One_Introduction.ppt

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